The Fundamental Theorem in Practice

Greg Mankiw

Recall the fundamental theorem of carbon taxation: Cap-and-trade = Carbon tax + Corporate welfare. You can see this at work in an article from the NY Times: How did cap and trade, hatched as an academic theory in obscure economic journals half a century ago, become the policy of choice in the debate over how to slow the heating of the planet? And how did it come to eclipse the idea of simply slapping a tax on energy consumption that befouls the public square or leaves the nation hostage to foreign oil producers? The answer is not to be found in the study of economics or environmental science, but in the realm where most policy debates are ultimately settled: politics. Many members of Congress remember the painful political lesson of 1993, when President Bill Clinton proposed a tax on all forms of energy, a plan that went down to defeat and helped take the Democratic majority in Congress down with it a year later. Cap and trade, by contrast, is almost perfectly designed for the buying and selling of political support through the granting of valuable emissions permits to favor specific industries and even specific Congressional districts. That is precisely what is taking place now in the House Energy and Commerce Committee, which has used such concessions to patch together a Democratic majority to pass a far-reaching bill to regulate carbon emissions through a cap-and-trade plan. During the campaign, candidate Obama had the edge over candidate McCain on this issue because he favored auctioning off all the permits. Sadly, the Congress seems to have now rejected this position. I wonder: Will the President now fight for his admirable campaign position? Or will he cave into the special interests to get a bill passed, even if it is highly flawed?

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